In Shaw v Doleman[2009] EWCA Civ 279 the Court of Appeal confirmed the view taken by some writers as to the effect of the disclaimer of an assigned lease on the obligations of a guarantor. At the same time it highlights that wording common in Authorised Guarantee Agreements (AGA’s) may not mean quite what the tenant thinks it means.

A lease has often been described as being “amphibious” in nature: partly a contract and partly creating an interest in land.

At common law a tenant who covenanted to do something in a lease (such as to pay the rent) owed that obligation to the lessor even if their interest (the tenancy) had been assigned to someone else. That could have harsh result. A tenant could “sell” their leasehold interest and many years later, perhaps after several transfers of the interest, they would receive a bill for unpaid rent due to the tenant for the time being’s failure to pay.

The Landlord and Tenant (Covenants) Act 1995 partially fixed this. When the tenancy has been assigned the former tenant is no longer liable to perform any of the covenants under the lease. But there is a catch, as the price for passing that rather tenant friendly provision, those representing landlords extracted a concession from the legislators: a landlord may in certain circumstances require a limited kind of guarantee — an AGA — from the tenant. An AGA may only be used to require a tenant to guarantee the next tenant’s breach of covenant, on any further assignment the original tenant is in the clear.

What happens if the assignee of the lease becomes insolvent? Here the Insolvency Act 1986 comes into play. If the assignee was a limited company then its liquidator will likely want to unburden itself of the covenants under the lease. The liquidator has the right to “disclaim” the lease and relieve the company of its liabilities under the lease.

But the way in which this is achieved is rather subtle. Rather than simply ending the lease on disclaimer, s. 178(4) of the Insolvency Act states:

A disclaimer under this section—
(a) operates so as to determine, as from the date of the disclaimer, the rights, interests and liabilities of the company in or in respect of the property disclaimed; but
(b) does not, except so far as is necessary for the purpose of releasing the company from any liability, affect the rights or liabilities of any other person.

The liabilities continue as far as any other person is concerned. That someone might be a guarantor, as the House of Lords found in Hindcastle v Barbara Attenborough Associates. The guarantor would still be liable under the covenants of the disclaimed lease even though (from the point of view of the assignee) that lease no longer existed.

In Shaw v Doleman Ms Shaw had been the tenant of a ground floor lock-up shop and basement. She had assigned the tenancy to the Ceramic Cafe Limited (CCL) and at the same time executed an AGA. The AGA required her to guarantee the assignee (CCL)’s liability under the lease “throughout the period during which the Assignee is bound by the tenant covenants of the Lease“. In the fullness of time CCL fell into liquidation and the liquidator disclaimed the lease.

You might think that the effect of the disclaimer and s.178(4) of the Insolvency Act would mean that CCL was not “bound by the tenant covenants of the Lease”. Not so, found the Court of Appeal, from CCL’s perspective it was no longer bound, but from any other person’s perspective — including of course Ms Shaw — it was so bound, so that the guarantee under the AGA was still effective.

I suspect that those drafting the AGA did not intend that consequence. Clause 5 of the AGA dealt with the disclaimer of the lease, giving the landlord the right to require Ms Shaw to take a new lease for the residue of the term provided notice was given within 3 months of the date of termination. That clause does not sit comfortably with the Court’s interpretation of the law.

I suggest that the problem was with the drafting of the AGA (which was apparently very similar to a precedent in the Encyclopaedia of Forms and Precedents). Hindcastle is quite clear as to the counterfactual manner in which s.178 works with which the Court of Appeal’s decision was entirely consistent. Timothy Fancourt’s Enforceability of Landlord and Tenant Covenants also suggests the same result.

I strongly suggest that those who check or draft AGA’s consider their wording carefully.